Benefits and risks of investing in emerging markets ETFs
Emerging markets ETFs can offer investors a variety of benefits.
- Potential for diversification and outperformance: Emerging markets ETFs can outperform when U.S. or other developed markets struggle, particularly during periods of U.S. dollar weakness.
- Access to high-growth companies: These ETFs provide exposure to businesses operating in some of the world's fastest-growing economies, including in sectors such as e-commerce, financial services, manufacturing, and natural resources.
- Long-term demographic tailwinds: Many emerging economies, such as India, benefit from expanding middle classes, rising incomes, and growing consumer demand, which can support long-term economic growth.
Investors should also keep in mind the risks associated with emerging markets ETFs.
- Higher volatility: Emerging markets are generally more volatile than developed markets due to country-specific risks, including political instability, corruption, weaker institutions, and regulatory changes.
- Government intervention: Investors face the risk of nationalization, capital controls, sanctions, or forced delistings if governments increase their involvement in financial markets or geopolitical tensions escalate.
- Currency risk: Unless an ETF hedges its foreign exchange exposure, fluctuations in local currencies can significantly affect returns. A strengthening U.S. dollar has historically created headwinds for many emerging market investments.
Methodology: How these emerging markets ETFs were chosen
When creating this list, we prioritized low expense ratios, substantial assets under management, strong trading liquidity, and long operating histories. Lower fees help preserve long-term returns, while larger, established ETFs generally offer tighter bid-ask spreads and a lower risk of fund closure.
We also favored broad, market-cap-weighted index funds over more specialized strategies. Market-cap weighting keeps portfolio turnover low, improving tax efficiency while naturally allowing the largest and most successful companies to become a greater part of the portfolio over time, rather than requiring frequent trading. That said, actively managed emerging market ETFs with competitive expense ratios were not entirely excluded.
Finally, we generally preferred unhedged emerging markets ETFs to currency-hedged alternatives. While exchange rates can create short-term volatility, currency movements have historically tended to wash out over long investment horizons, whereas hedging introduces additional costs and can create a persistent performance drag.
The bottom line
Emerging markets ETFs can be a valuable addition to a diversified portfolio, offering exposure to faster-growing economies and markets that may outperform developed countries over certain periods. At the same time, they require more due diligence than a typical U.S. index fund because seemingly small methodological differences can lead to meaningfully different portfolios.
Before investing, read the ETF's index methodology carefully. Index providers such as MSCI and FTSE classify countries differently, so two emerging-markets ETFs may have very different exposures despite similar names.
Finally, pay attention to liquidity. Emerging markets ETFs often trade with wider bid-ask spreads than comparable U.S. equity funds, making it worthwhile to review trading costs before placing an order.
Ultimately, the best emerging markets ETF is the one that aligns with your investment objectives, risk tolerance, and time horizon. Understanding what the ETF owns and how it achieves that exposure is often more important than chasing the strongest recent performance.
